Are You a Magician or a Business Person?

I used to be a guitar hero. Or so I thought. In a band. Made two records (and the “lost” album). Gibson Les Paul Custom around my neck. Marshall 100W stack. I could play a reasonable lead guitar line.

Now, the idea of playing lead guitar when you cannot play lead guitar seems daunting. How do you move your fingers so quickly? How do you know where to put your bloody fingers in the first place? How to you get that bendy wailing sound?

You can’t do it because…

…it’s magic. It requires special skills that you don’t have. There’s a secret club where they share out the knowledge and you have not been invited. It takes years of practice. You have to be born this way, as Lady Gaga might say, when not tweeting nude pics of herself. You have to be gifted/lucky etc etc.

No…no…no…

There is no magic.

What there is is the pentatonic minor scale. A dozen or so finger positions, a few techniques (what Keith would call “licks, man”) and that’s you – Rock God.

A few weeks practice in your bedroom instead of homework and you’re away – a fully fledged babe-magnet. It’s that simple.

Why do you think the guitar is such an enduring instrument? Because it’s sexy, dirty and easier to play that a kazoo.

Which takes me neatly to Warren Buffet…

His company Berkshire Hathaway has the best risk-adjusted return of any stock in the period since 1976 (ha! – a year when a lot of people picked up a guitar for the first time as punk swept the land.) A lot of people think Buffet has unique and mystic powers of insight. He can see what others cannot see. He has the gift; the magic foo-foo dust. Other investment houses they come and they go, they shine and then they expode. Meanwhile old Buffet keeps on chugging along with his homey wisdom and his out of this world long-term investment returns.

But you see…

…Warren has his own pentatonic minor scale. He has the finger positions and the licks. He is not a God. But he is a strategist and he is clever, and he has set himself up to win. He is a man with a plan and he’s been executing it for 40 years…calmly and collectedly in an industry full of chancers and this-time-it’ll-be-different delusionists.

This is all revealed by Andrea Frazzini and David Kabiller from New York University and AQR Capital Management.

They explain…

Here’s what most investment houses do –

They buy volatile shares with high risk/reward ratios (it doesn’t matter why they do this – there is a reason, but let’s just accept that they do this). Because they all do this, what they buy is in demand and therefore over-priced and they end up with portfolios that are more volatile than the market and also underperform. Yuk. That’s your money that is.

Good old Warren…

…he does things differently. He buys low volatility stocks which are cheaper because there is less demand. But they also produce lower returns so he borrows huge piles of cash to leverage his portfolio (something most of the other guys are not allowed to do).

So far so obvious…

…but he borrows a large part of what he needs from his own cash-rich insurance companies (cash-rich because they gather your premia before you claim for that camera you, eh, lost on the beach at Torremolinos). And he does so at a low interest rate: 2.2% for him vs 5%+ for those competitors of his who are allowed to leverage.

He’s just a normal guy…

…his core investment returns are “unspectacular” say Frazzini and Kabiller. His undoubted success has come from very clever leverage.

There is no magic. No Santa. No tooth fairy. There’s a business model that is different, that works and that has been tirelessly implemented for decades. You might call it a “process”.

My best clients understand that almost everything in their business is a process. It might be a bloody clever process but a process none the less, which, once defined, can be replicated.

Once this is understood you can teach your process to others. You can outsource it, which means you can scale your business beyond anything you could ever do yourself, and, if you want to, you might even be able to sell the damn business one day.

So there we have it…”process” is the secret to escaping the hamster wheel that is the default destiny of the unaware small business/self-employed person. It is the route to gaining wealth (a.k.a. freedom) and carving out the time necessary to devote yourself to something worthwhile like playing a great guitar solo.

Thanks for the second week in a row to The Economist for alerting me to Frazzini and Kabiller’s work.